7 - A Tale of Two Crises: The Great Depression, the Financial Crisis and the TEM Flashcards
(10 cards)
What do the most severe recessions often have in common?
Financial component.
How did the Fed initially try to combat the Great Depression?
Raising r in late 1928 as stock prices were thought of as “too high”.
Caused investment to fall, credit constrained households spent less as loans were harder to come by.
What response did households have to the net worth shock of the Great Depression?
The reduction in home equity, financial wealth and expected future earnings led people to save to restore target wealth. This caused c to fall, causing AD to shift downwards even more.
What can we say in terms of game theory about the responses households had to the net worth shock of the Great Depression?
It is an example of a social dilemma.
Individually rational behaviour brings about socially suboptimal outcomes.
How did policymakers cause further problems turning the recession into a depression?
The real rate of interest rose due to falling prices, shifting the economy back up the IS curve.
Rather than continuing to cut r in 1932, they raised r to increase inflows of gold as the gold standard formed the exchange rate, causing a wave of banking failures.
During the GFC, where did low real rates come from?
- Low nominal rates
(understanding that internal stab. is more important than the exchange rate)
New tools such as Q.E. - Positive inflation exp.
PC anchored therefore less likely deflation trap
How did policy during the Great Depression differ from the GFC?
- Larger and faster intervention in banking markets
(CB as lender of last resort to IBs and high street banks) - Great deal of international cooperation
- Expansionary fiscal policy in an attempt to combat AD falls
What is the WS equation?
W/P = WS
W/P = F(u,z)
u = unemployment, z = other factors (unemployment benefits, TU power etc.)
What is the equation for leverage ratio?
Assets/equity = leverage ratio
Which of the following statements are correct?
A leverage ratio of 40 means that only 2.5% of the asset is funded by equity.
The total asset value of US banks doubled between 1980 and later 1990s.
A leverage ratio of 25 means that a fall of 4% in the asset value would make a bank insolvent.
UK banks increased their leverage rapidly in the 2000s in order to make more loans to UK house buyers.
A = equity/assets = 1/40 = 2.5%
C = equity = 1/25 = 4% of total assets. If asset values fall by 4%, the bank loses it’s entire equity buffer.
